Personal Finance 101 with H. Swint Friday

Cash in on Social Security sooner or later?

As prospective retirees enter their 60s, one important decision they face is whether to take their Social Security benefits early when they reach age 62 or to wait and let the benefits grow before taking them.

This question is more complicated than just straight financial analysis when one considers the decision in the context of the looming Social Security crisis created by the mass of baby boomer retirees who will start qualifying for benefits in the next 20 years. Making an educated decision will require some prognosticating on what the powers that be will do to address this problem.

A cursory look at the payout differentials gained by delaying distributions appears to indicate that it pays to wait and let the benefits grow. Those who start taking distributions at age 62 will receive about three-fourths of the distribution they would receive if they waited until full retirement, currently at age 66. That is, by waiting four years, one increases the annual distributions by 33 percent. However, to make a more accurate decision, soon-to-be retirees should consider their work status at age 62, the value of their investment accounts and expected rates of return on their invested money.

Those working at age 62 wishing to collect benefits may lose as much as 50 percent of their benefits to taxes depending on their income until they reach full retirement age. For those in this group who have enough current income to support themselves without benefits, it may pay to wait until full retirement age to start collecting benefits. However, for those who are retired at age 62, from a time value of money perspective, it generally pays to start collecting benefits immediately because of the very low returns generated within the Social Security system. If they can obtain a return of 5 percent or higher, the break-even point for waiting until full retirement to start taking benefits is well into their 80s. So, the decision to wait involves gambling against current life expectancy tables.

Considering the looming crisis of the system, this decision becomes even clearer for most retirees. In the 1930s when the Social Security program originally was conceived and implemented, it provided a badly needed retirement safety net for hardworking Americans recovering from the financial devastation of the Great Depression. At this time in our nation's history, average working folks did not have access to the financial markets via mutual funds and online trading accounts and the wide array of financial advisers now located on just about every corner to help them develop retirement plans to see them through their golden years. These options were only available to the well-heeled with ample resources to invest.

However, the system as originally designed and in its current form is outdated and has serious fundamental flaws that must be addressed in the near future to remain solvent. When the Social Security system first opened its doors, there were plenty of working people paying into the program to support the limited number of retirees collecting benefits. In the future, there simply will not be enough people paying into the system to support all of the retirees. By 2030, every working family in America will have a retiree to support in addition to their own family. This is not a tenable situation.

To maintain solvency of the current system, Social Security taxes will have to be raised substantially and/or benefits will have to be cut substantially. With the real possibility of future benefit cuts or increased taxes on benefits, a bird in the hand is worth two in the bush. Why should one wait for promised higher benefits if there is good chance they will be cut anyway? These promises will in all likelihood prove hollow for retirees.

Many groups have been working diligently to propose innovative solutions for the future of Social Security. Most have determined that the best solution is to transform the program completely to be more competitive with private-sector alternatives and even public-sector plans available to both federal and state employees that provide benefits and risk-adjusted returns far superior to that of the current system. These solutions probably will arrive too late because the system may have to experience complete bankruptcy or at the very least see taxes become so high and benefits cuts so deep that they are unpalatable to working Americans before the political will develops to initiate the changes necessary to sustain the system for future generations.

H. Swint Friday is a professor of finance at Texas A&amp;M University-Corpus Christi. He has a doctorate in finance and a master's in economics from Florida State University, and is a certified financial planner.